IRS issues reminder on tips

The IRS has issued a reminder on tips. According to the IRS, that automatic gratuities are service charges, not tips. Employers should make sure they know the difference and how they report each
to the IRS.

What are tips?

Tips are discretionary (optional or extra) payments determined by a customer that employees receive from customers. Tips include:

1. Cash tips received directly from customers.
2. Tips from customers who leave a tip through electronic settlement or payment. This includes a credit card, debit card, gift card, or any other electronic payment method.
3. The value of any noncash tips, such as tickets, or other items of value.
4. Tip amounts received from other employees paid out through tip pools or tip splitting, or other formal or informal tip sharing arrangement.

Certain factors are used to determine whether payments constitute tips or service charges. The absence of any of the following factors creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge:

1. The payment must be made free from compulsion;
2. The customer must have the unrestricted right to determine the amount;
3. The payment should not be the subject of negotiations or dictated by employer policy; and
4. Generally, the customer has the right to determine who receives the payment.

What are service charges?

An employer or employee’s characterization of a payment as a “tip” is not determinative. Again, the absence of any of the four factors listed earlier creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge. Examples of service charges commonly added to a customer’s check include:

1. Large dining party automatic gratuity
2. Banquet event fee
3. Cruise trip package fee
4. Hotel room service charge
5. Bottle service charge (nightclubs, restaurants)

Generally, service charges are reported as non-tip wages paid to the employee. Some employers keep a portion of the service charges. Only the amounts distributed to employees are non-tip wages. (IRS FS-2015-8, Tips versus Service Charges: How to Report, February 2015.)

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